For release on delivery12 0 0 p m , E D TJuly 10, 1998

Remarks by

Alan Greenspan

Chairman

Board of Governors of the Federal Reserve System

at the

Charlotte Chamber of Commerce

Charlotte, North Carolina

July 10, 1998

It is a pleasure to be in Charlotte today Before I ever visited your fair city or

state, indeed, before I had traveled very far from the environs of Yankee Stadium, I

developed a special affinity for Charlotte In the evenings when I was a boy, I often

tuned in the clear radio channel stations around the country-those assigned a unique

wavelength-and WBT Charlotte was one that I recall listening to quite often when the

atmospherics were just right By that time radio was not exactly on the cutting edge of

technology, but it was not very far from it either In those days, no one thought of

Charlotte as an important national banking center, but as we moved from the vacuum

tube of radio to the transistor and sihcon chip of current technology, both technological

change and the resulting erosion of restrictive laws have permitted creative management

to establish financial centers in this country wherever convenient

The implications of today's relentless technological changes are my subject matter

this afternoon

The United States is currently confronting what can best be described as another

industrial revolution The rapid acceleration of computer and telecommunications

technologies is a major reason for the appreciable increase in our productivity in this

expansion, and is likely to continue to be a significant force in expanding standards of

living into the twenty-first century

Technological change is but one part of a broader set of forces an ever increasing

conceptualization of our Gross Domestic Product-the substitution, in effect, of ideas for

physical matter in the creation of economic value The roots of increasing

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conceptualization of output lie deep in human history, but the pace of such substitution

probably picked up in the early stages of the first industrial revolution, when science and

machines created new leverage for human energy Nonetheless, even as recently as the

middle of this century, the symbols of American economic strength were our outputs of

such products as steel, motor vehicles, and heavy machinery—items for which sizable

proportions of production costs reflected the value of raw materials and the sheer manual

labor required to manipulate them Since then, trends toward conceptualization have

focused today's views of economic advancement increasingly on downsized, smaller, less

"concrete" evidence of output, requiring more technologically sophisticated labor input

The radio on which I listened to WBT was activated by large vacuum tubes, today

we have elegantly designed pocket-sized units using transistors to perform the same

function—but with the higher quality of sound and greater reliability that consumers now

expect Thin fiber-optic cable has replaced huge tonnages of copper wire Advances in

architecture and engineering, as well as the development of lighter but stronger materials,

now give us the same working space, but in buildings with significantly less concrete,

glass, and steel tonnage than was required in an earlier era

The process of conceptualization in output seems to have accelerated in recent

decades with the advent of inventions such as the semiconductor, the microprocessor, the

computer, and the satellite The cutting edge of the new technologies is evidenced by the

huge expansion in the dollar value of international trade, but significantly not so in

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tonnage. Pounds per inflation-adjusted dollar of American exports, for example, have

been falling several percent per year during the past two decades

In the 1980s and early 1990s, many of us were puzzled that the growth of output

as customarily measured did not evidence a pickup Of course, output may have been

measured incorrectly But is it also possible that some of the frenetic pace of change was

mere wheel spinning-changing production inputs without increasing output-rather than

real advances in productivity

A number of commentators, particularly Professor Paul David of Stanford

University, suggested a decade ago that much of the wheel spinning, if that is what it

was, reflected the extended time it typically takes to translate a major new technology

into increased productivity and higher standards of living Indeed, it was conjectured

that the big increases in productivity resulting from the introduction of computers and

communications equipment lay in the future If true, he pointed out, this would not be

historically unusual Past innovations, such as the advent of electricity or the invention

of the gasoline-powered motor, required considerable infrastructure before their full

potential could be realized

Electricity, when it substituted for steam power late last century, was initially

applied to production processes suited to steam, Gravity was used to move goods

vertically in the steam environment, and that could not immediately change with the

advent of electric power It was only when horizontal factories, newly designed for

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optimal use of electric power, began to dominate our industrial system many years after

electricity's initial introduction, that productivity clearly accelerated

Similarly, it was only when modern highways and gasoline service stations

became extensive that the lower cost of motor vehicle transportation became evident

While the evidence of a pickup in long-term productivity growth is still sparse,

recent accelerations in output per work hour have lent some credence to Professor

David's speculations

The same forces that have been reshaping the real economy have also been

transforming the financial services industry Once again, perhaps the most profound

development has been the rapid growth of computer and telecommunications technology

The advent of such technology has lowered the cost and broadened the scope of financial

services These developments have made it increasingly possible for borrowers and

lenders to transact directly and for a wide variety of financial products to be tailored for

very specific purposes As a result, competitive pressures in the financial services

industry are probably greater than ever before

Technological innovation has accelerated another major trend-financial

globalization-that has been reshaping our financial system, not to mention the real

economy, for at least three decades Both developments have expanded cross-border

asset holdings, trading, and credit flows In response, both securities firms and U S and

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foreign banks have increased their cross-border operations Once again, a critical result

has been greatly increased competition both at home and abroad

Still another development reshaping financial markets—deregulation—has been as

much a reaction to technological change and globalization as an independent factor The

sharply enhanced market signals emanating from the vast set of technology-driven new

products have undermined much regulation which rested on the ability to maintain

market segregation Moreover, the continuing evolution of markets suggests that it will

be increasingly difficult to support some of the remaining rules and regulations

established for a different economic environment While the ultimate public policy goals

of economic growth and stability will remain unchanged, market forces will continue to

make it ever more difficult to sustain outdated restrictions, as we have recently seen with

respect to interstate banking and branching

But change often comes slowly, and is viewed as threatening by many Indeed, it

is frequently difficult to reform the rules of the game, as it were, because change requires

easing rules and opening options for some while increasing competition for others,

redrawing lines that create new limits, and applying some pre-existing regulatory

structures to new institutions However, in my judgment, our financial system has clearly

reached the stage where pressures from the market will force dramatic changes regardless

of existing statutory and regulatory limits The ability of financial managers to innovate

and find loopholes seems endless

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Recognizing this reality, the congressional leadership appears to have made the

decision to attempt to fashion a new set of rules that are both comprehensive and

perceived as equitable to all participants

For the Federal Reserve, the basic focus of such a redesign has been the

implications of expanded powers, that we fully support, on the special benefits now

provided to banks by the federal safety net In order to help assure stability in the

banking system, our society has chosen to provide banks with deposit insurance, access

to the discount window, and payment system guarantees. These privileges, while

succeeding in enhancing the stability of the system, have also provided a subsidy to

banks in the form of a lower cost of funds Access to the sovereign credit of the United

States has meant that bank creditors feel less need to be concerned about the risk-taking

of their bank. This requires that the government oversee the risk exposure of banks

through supervision and regulation, that is, for government to substitute itself for the

market discipline faced by those financial businesses that do not have access to the

federal safety net

In the Federal Reserve Board's judgment, the dismantling of Depression Era

separations of financial activities must consider the necessity of containing the safety net

subsidy within the existing banking system The more the safety net is expanded to cover

new financial activities the greater the potential that risk-taking will not be subject to

market discipline, that bank-like supervision would need to be applied over a wider

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range, and that financial innovation--the hallmark of the U S financial system-will thus

be constrained

In May, as you know, the House of Representatives passed financial

modernization legislation, H R 10, that permits banks, securities, and insurance firms to

affiliate Recognizing the problems of the safety net I have just discussed, the House

adopted the holding company structure, and not the universal bank structure proposed by

the Treasury, as the appropriate means to allow the new securities and insurance

affiliations That decision is fundamental to the way in which the financial services

industry will develop in the 21st century

The Treasury supports giving national banks the authority to conduct, through

subsidiaries of banks, the same powers that are contemplated for the holding company in

H R 10 Under this approach, equity investments by a bank in its subsidiary can be

financed at the same subsidized cost of capital available to the bank itself The subsidy

results from the bank's access to the safety net

As a consequence, the bank's operating subsidiary (or "op sub") would have a

subsidized advantage in competing with nonbanking financial institutions endeavoring to

offer the same services In contrast, when these services are financed through an

essentially unsubsidized affiliate of a holding company, as mandated by H R 10, that

competitive advantage is largely neutralized Although the Board strongly favors the

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new powers embodied in H R 10, we believe they should be financed by the

marketplace, not subsidized with the sovereign credit of the United States

Importantly, large losses in the bank op sub can also imperil the bank and the

deposit insurance reserves Uninsured holding company affiliates provide much greater

protection for the banks, the insurance funds, and ultimately the taxpayer

In addition, should banking organizations be offered a choice between placing

new powers in an op sub or a holding company affiliate, they will, if profit is their goal,

invariably choose the op sub and its subsidized funding As a consequence, the holding

company structure would atrophy in favor of the universal bank This is not a problem in

itself But the Federal Reserve's current ability to confront a financial crisis

expeditiously rests on our role as holding company supervisor—a regulatory regime that

would be quite difficult to replace Potential significant loss of adequate Federal Reserve

hands-on supervisory capability has become an especially important issue in light of the

increase of banking megamergers

The House-passed bill creates real difficulties for some observers since it would

not permit commercial affiliations with banks Technological change has already eroded

the distinction between some financial and nonfinancial products This erosion will only

accelerate in the years ahead Nonetheless, we at the Fed agree with the House decision

simply because it is exceptionally difficult to predict with any degree of certainty the

implications of combining banking and commerce Since the decision to do so would

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surely be irreversible, we would prefer, therefore, that the rather far-reaching financial

reform embodied in H R. 10 be digested before we proceed toward combining banking

and commerce There is no time or market urgency that requires haste Moreover, the

Asian crisis has highlighted some of the risks that can arise if relationships between

banks and commercial firms are too close It is not so much that U S entities would

evolve structures like those in Indonesia, Thailand, or Korea Rather, it is the experience

that the interaction of complex structures can make it extremely difficult for management

to monitor, analyze, and oversee financial exposures

I do wish to note, however, that while H R 10 would permit financial affiliation

over a wide range, and while current and proposed mergers would create nationwide

banks and financial service companies, not all institutions would prosper as, nor desire to

be, financial supermarkets Many specialized providers of financial services are

successful today, and will be so in the future, because of their advantages in specific

financial services Moreover, especially at commercial banks, the demand for traditional

services by smaller businesses and by households should continue to flourish And the

information revolution, while it has deprived banks of some of the traditional lending

business with their best customers, has also benefitted banks by making it less costly for

them to assess the credit and other risks of customers they would previously have

shunned Thus, it seems most likely that banks of all types will continue to engage in a

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substantial amount of traditional banking, delivered, of course, by ever improving

technology

Community banks, in particular, are likely to provide loans and payments services

via traditional banking Indeed, smaller banks have repeatedly demonstrated their ability

to survive and prosper in the face of major technological and structural changes by

providing traditional banking services to their customers The evidence is clear that

well-managed smaller banks can, and will, exist side by side with larger banks and other

financial services providers, often maintaining or increasing local market share

Technological change has facilitated this process by providing smaller banks with low-

cost access to new products and services In short, the record shows that well-managed

smaller banks have little to fear from technology, deregulation, or consolidation

Most projections of the future United States banking structure call for a

substantial reduction in the number of American banks But these same projections also

predict that thousands of banks will survive the consolidation trend, reflecting both their

individual efficiencies and competitive skills, on the one hand, and the preferences of the

marketplace on the other Such conclusions of the Federal Reserve Board's staff and

others reinforce my own view that the franchise value of the U S community

bank-based on its intimate and personalized knowledge of local markets and customers,

its organizational flexibility, and, most of all, its management skills-will remain high,

assuring that community banks continue to play a significant role in the U S financial

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system Technology can never fully displace the value of personal contact, the hallmark

of community banking

In closing, let me simply reiterate that the pace of technological change, of

globalization of markets, and of the pressures for deregulation can only increase These

changes are affecting both financial and nonfinancial institutions around the world In

most American industries, the responses to these market forces do not require either the

Congress or an agency of government to grant permission for the necessary adjustments

However, many of our regulated financial institutions find themselves unable to respond

in the most efficient and effective way because of outdated statutory limitations If these

are not revised, my reading of history suggests that the affected entities will find ways to

survive, but using methods that do not provide the highest quality and lowest cost

services to the American public Only Congress can establish the ground rules to assure

that competitive responses provide maximum net benefits to consumers and a fair and

level playing field for all participants

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